Here's the Russell 2000 as of Friday's close:
Here's another index that rhymes with the Russell:
As I stated in my introductory remarks although technical damage has been done to these markets on a short term basis, some of our inter market relationships are turning positive for stocks.
Treasuries had been on a tear since March but we have seen them go over to a somewhat corrective mode in June:
Here's the Dow Jones CBOT Treasury Index which is composed of 30-Year T-Bond, 10-Year T-Note and 5-Year T-Note futures contracts and replicates the performance of the U.S. Treasury bond market. Treasuries are poised to break down under a support line (purple dashed) set from the March bottom. The momentum indicators are all signaling significant weakness. As per our inter market relationships weakness in Treasuries is a positive for stocks .
Now we have to keep a perspective here. Treasuries are at lofty levels and a back up would be natural and even desirable for bond bulls. Even if we break the trend line I'd want to see RSI (top panel) drop under the 40 level and preferably the 30 level before I would pronounce this market in a correction. But if we get there stocks will rally!
Now, to put a damper on my comments above:
Speaking of the Euro, the speculative position in the CFTC Commitment of Traders report for the week ending June 19 showed a large reduction of net short euro futures. With the threat of a short squeeze greatly ameliorated we could see a strengthening Dollar this week.
I've marked Friday's close (black arrow) and we've penetrated another inner downtrend line (green dashed). We're fast approaching double bottom territory at around $1,523.00 (where Gold bottomed in late December 2011 and Mid May 2012) and if we close below that price Gold has a lot more downside. The divergence on CCI (bottom panel) that I identified in last week's commentary corresponding to the short term double top in the metal (solid blue line on the chart) was predictive of the move we saw this week.
I believe Gold's weak performance since last September is telling us something important and I'm going to be tying its price action in with events in Europe and China in my analysis below.
Commodities were actually showing some signs of life this week until Wednesday when the FOMC made their annoucement after their meeting. The price movement as a response to that announcement and Bernanke's remarks after the FOMC meeting was confirmation that it wasn't an anticipation of economic growth that was moving the commodity complex higher, but "hopium" (the market's addiction to central bank induced liquidity).
Here's a daily chart of Brent North Sea Crude going back to January 2010:
We've penetrated the 61.8% Fibonacci support level and the momentum indicators are deeply oversold and/or screaming for more downside. We must remember that Fibonacci lines are better viewed as levels and though you can often see an index, ETF or stock stop on a dime at a Fibonacci line it is better to consider the general level as an area of support or resistance.
Oil is telling us that the global economy is weakening a lot faster than equities would lead us to believe. I know some people are attempting to pick a bottom in this market. The prevailing opinion seems to be that it can't go much lower. I don't know about anyone else but I'm not going to stand in front of this Mack truck coming down the hill at me! I'll let the charts tell me if/when to get in on the long side. Brent did pop on Friday and was up $1.75 for the day. But the Market Vectors Oil Services ETF, which has been historically predictive of moves in oil in the past was down:
I've delineated the price action in the ETF with Brent (bottom panel).
Europe continues to be center stage but the market is starting to act like it is numb to all the news. Interestingly, in spite of the dire political and financial situation there, yields on peripheral bonds have been dropping over the past week. Rates on Spain's 10 year bond closed on Friday at 6.354% after being over 7% earlier in the week. Italy and Portugal are seeing the same drop in yields. I think the market liked the latest announcement out of the meeting in Rome between Merkel, Hollande, Rajoy and Monti where they will be proposing a 130 billion euro growth package at the EU summit this Thursday and Friday. Never mind that no one has said where the money is going to come from! And much of the ideas have been proposed and rehashed before.
Nevertheless, for all the fears of an imminent implosion over there when you look at yields, stocks and other indicators it appears that market concerns of imminent disaster appear to be diminishing. How long this will last is anyone's guess.
Now, despite the seeming easing of fear nothing has changed in the Euro zone and the current evolution of the crisis and the key issues are really quite simple to understand (for a change). The market's knee jerk reaction to any news coming out of Europe is symptomatic of a fundamental misunderstanding or ignorance by many market participants on the mechanics of the problem and the conflicting economic philosophies of the major political players of the EU member states. But we're getting down to the "nitty gritty" over there and I can sum it up for traders and investors in a few points:
1. If you here about any proposals to finance banks through the ESM or EFSF just remember, Germany will not agree to any kind of mutualization of debt, meaning any action that would share that debt with all the EU members. Germany considers this a moral hazard (as I do).
2. If you hear about any proposals to guarantee bank deposits throughout the EU just remember, Germany will not agree for the same reasons in point #1.
3. The only way that Germany will agree to points 1 & 2 is if EU individual member states agree to cede their fiscal sovereignty to a central governing authority.
Will individual EU member states agree to cede their fiscal sovereignty? I have my doubts but it does seem that as these countries get backed into a corner and are faced with leaving the union and going it alone or staying their political rhetoric has been decidedly dovish toward such a prospect. I read an article recently that stated in so many words that the next crucial phase in the political and fiscal unity of the European Union will be accomplished through crisis because that's the only way these member nations will do what they have to in order to preserve that union.
In the meantime, as long as the European bond market is willing to cooperate, the extreme volatility that we dealt with last fall in the stock market will be mitigated to a great extent, regardless of other macro factors.
Many market participants like to use the CBOE Volatility Index (VIX) as an accurate barometer to measure fear in the market. And while I too like the VIX in order to gauge fear in the stock market I also use the Three Month T-Bill Discount rate to measure fear in the entire global financial system:
If anyone reading this has a thesis on why this is occurring please let me know. It seems to me that the Euro zone crisis is now at a "make or break" crossroads. And the latest data from the most recent bond auctions was that the main buyer of Spanish and Italian sovereign debt were Spanish and Italian banks! This kind of financial incest cannot last.
No matter, it is what it is and we as traders/investors need to play the hand Mr. Market deals us.
Gold is clearly reacting to severe deflationary forces that are beginning their take over of the global economy. Germany is contracting, the periphery nations are in depression (that's right; not recession). China, the tail that the dog is wagging, is also contracting. Central banks are starting to wean equity markets off of the "hopium" they've become hooked to because of the realization that they are now pushing on a string to spur growth (aka credit demand). Slowly but surely, behind closed doors, politicians and the power elite of the world are discussing how they can ease the developed nations into the severe deleveraging that must take place in order to get the global economy back on a growth projection. That is why Bernanke and Draghi refuse to print anymore money and will continue to do so until they are cornered by those same deflationary forces that are currently "walking to and fro" across the earth. And Gold, by its price action, is telling us all this.
I expect Gold to continue to correct because of the phenomena I've identified above. And when the time comes that it forms a base, it will be apparent to all whether it based because the deleveraging was complete or because central banks relented and opened the liquidity spigots.
I've debated many in the past few years who believe that central bankers will not be able to help themselves but will do whatever it takes to save the current system. My retort has always been that central bankers will not cut off their nose to spite their face. They know that currency debasement can only go so far in attempting to deleverage the world economy and that a vast expansion of fiat currency would not save the system but hasten its end. In essence my argument is this: If you're a global power elite and you know that the present policy you're on will end with the punch bowel being taken away from you, will you continue on the same path? My answer to that is NO!
So, my thesis based on what the Three Month Discount Rate and Gold are telling me is that:
1. Deflationary forces are finally starting to win the inflation/deflation battle.
2. Europe will somehow muddle thru but the depression in the periphery nations has already spread like a cancer to China and is starting to impact the US.
3. Stocks will start a slow but steady decline akin to the great bear market that started in November 1968 and ending in August 1982 culminating with a universal psycological antipathy toward stocks.
The only alternative to this would be if my thesis regarding central bankers is wrong and they fire up the printing presses. If this happens I can assure you that you will wish my thesis was correct!
So, what events next week may override the bleak short term technical picture we see?
1. The Supreme Court is due to rule on Obamacare as early as Monday. Intrade presently puts a 75% chance that they will overrule the law. I addressed this in last week's commentary. Look for an overruling to be met with a market rally and the opposite will cause a sell off.
2. The EU summit next Thursday and Friday will end with a lot of flowery rhetoric regarding fiscal unification, etc. Just remember my points above and you won't go wrong. Nothing changes until everyone agrees to Germany's formula. Period! And here's some anecdotal evidence that gives insight to the German mindset on these issues and supports my statements above. This is a quote from David Bahnsen's (Senior Vice President, Morgan Stanley Smith Barney) weekly newsletter containing a quote from Scott Minerd of Guggenheim partners:
"On October 3, 2010, Germany made a $94 million payment towards an old debt it had. This was its very final payment - of its WORLD WAR I DEBT REPARATIONS! Germans know full well what taking on excessive debt has historically meant to a nation, and how long it can take to come out from under it."
Merkel will not give in to the pro growth (aka pro hand out) faction in the EU and regardless of their rhetoric, they are held captive because Germany is the bank! Remember that and you'll always be on the right side of any trade that Europe impacts, regardless of any press releases.
Have a great week!
NOTHING IN THIS COMMENTARY SHOULD BE CONSTRUED AS AN OFFER OR ADVICE TO BUY OR SELL ANY SECURITIES, OPTIONS, FUTURES OR COMMODITIES. THE OPINIONS ARTICULATED ARE ONLY THIS AUTHOR'S WHO IS NOT A REGISTERED INVESTMENT ADVISOR OR BROKER.